Slovenia joins the euro -- with fanfare

Lure of macroeconomic stability overcomes fears of higher prices

By

AudeLagorce

LONDON (MarketWatch) -- Slovenia will on Jan. 1 become the first former communist state to adopt the euro, in what Prime Minister Janez Jansa has called the "biggest national achievement" since the country joined the European Union in 2004.

This is no small victory for the country of 2 million inhabitants, which shares borders with Italy, Austria, Croatia and Hungary. It is alone among the 10-member European Union accession class of 2004 in having fulfilled the rigorous economic criteria needed to join Europe's Economic and Monetary Union.

The adoption of the single currency is expected to bring macroeconomic stability to the country, boost its exports and yield productivity gains.

"It's difficult for a small country to maintain a separate currency that isn't a volatile currency," said economist Iain Begg, a visiting professor in the European Institute at the London School of Economics. "The adoption of the euro should protect Slovenia from external factors that would lead to swings in demand for its goods and services."

On the downside, by giving up its ability to fix its interest rates, Slovenia exposes itself to the risk of a house-price boom such as those experienced by Ireland and Portugal after they joined.

Price fears often ungrounded

To enter the monetary union, Slovenia has swallowed some bitter pills. But the reforms have paid off. The country has brought down inflation to 2.3% in 2006 from 8% in 2001, thanks to a collective effort that saw even labor unions agree to moderate wage increases.

The transition to the euro will be quick, if not entirely painless, with the Slovene tolar and the euro in dual use for just 14 days. After that, the euro will be the sole currency.

The government has taken precautions to make the changeover as smooth as possible. For instance, the euro value of products has been tagged to all prices in Slovenia for nearly two years. A manual explaining the switch has also been sent to every household.

'It's difficult for a small country to maintain a currency that isn't a volatile currency.'
Iain Begg, LSE

Despite some natural fears of initial confusion, a recent E.U. survey found that more than two-thirds of Slovenes are happy to adopt the euro, with many saying they see it as further proof their country, a former Yugoslav republic, is part of mainstream Europe.

But concerns that the transition to the new currency could herald price hikes have also emerged. In a bid to assuage those fears and to discourage retailers from using the transition as an opportunity to hike prices, the Slovenian government has decided to leave double-pricing tags in place until June.

Among other measures, it has also urged producer organizations and retailers to promise not to raise prices and encouraged consumer groups to closely monitor the situation.

Begg, however, contended that fears of inflation are not always rational. "There are bound to be some exceptional cases, but the overall picture will almost certainly not be inflationary," he said, noting that inflation in the euro zone has been very low.

On the positive side, economists said the adoption of the euro should help stabilize Slovenia's economy.

Jean-Loic Guieze, an economist at BNP Paribas, said that, as a tiny economy, Slovenia is heavily exposed to trade and hence international competitive pressures. As a result, the country's economic growth will be heavily reliant on its ability to boost exports.

"Against this backdrop, adopting the currency of its main trading partners will have a positive impact as it cuts transaction costs and eliminates exchange-rate risks," Guieze said. "This should stimulate foreign direct investment, which in turn could trigger an acceleration of productivity gains."

Commission lauds currency's success

Meanwhile, in Brussels, the European Commission earlier this week trumpeted the success of the euro, saying the number of bank notes in circulation had virtually tripled in the five years since the currency was introduced.

The commission stated that most residents were happy with the currency, although many still associate its introduction with steep price rises.

"The euro has brought us many advantages," E.U. Monetary Affairs Commissioner Joaquin Almunia said in a statement, listing low inflation and interest rates among them.

"Let's make people aware of these benefits ... so that they take advantage of them rather than using the euro as a scapegoat for other problems," he said.

He reported that the inflation rate stood only slightly above 2% and said the distorted perception that the euro had brought price increases could be explained "by the bad impression caused by some abuses in certain sectors and certain countries around the changeover in 2002 and the generally observed psychological tendency to note price increases more readily than price decreases."

In other words, "people notice when the price of their café au lait goes up -- less so when prices go down," Begg said.

Not there yet

By joining the euro zone, Slovenia has distinguished itself from the nine other countries that entered the E.U. in 2004. None of them will be adopting the euro next week, often because of high inflation or runaway government deficits.

Among the nine newcomers of 2004, the big three -- Poland, the Czech Republic and Hungary -- have faced the biggest problems. Their difficulties, in fact, are so severe that they have now switched places with Malta, Cyprus and Slovakia as the next likely entrants to the monetary union.

Begg explained that larger countries are less inclined to take the strict measures needed to enter the monetary regime because they have an alternative, being big enough to maintain a separate currency, an option that is "simply not realistic" for smaller states.

The Czech Republic and Hungary abandoned their 2010 targets this year. Poland, which never set a formal goal, plans a euro referendum in 2010, which would push back euro adoption to 2012 or beyond.

Brussels this year also dashed any lingering hopes among the Poles, Hungarians and Slovaks that they could deduct the costs of pension reforms from their budget deficits.

Lithuania, meanwhile, suffered a bitter disappointment when it failed the inflation test by a fraction of a percentage point this summer. Baltic neighbors Latvia and Estonia also stumbled over inflation.

Still, Begg said, the smaller countries that joined in 2004 "all have ambitions to join the [monetary union] as soon as possible."

Bulgaria and Romania lag

Slovenia's fellow former communist and southeastern European states Bulgaria and Romania, meanwhile, may be joining the E.U. on New Year's Day, but they still have a long way to go to measure up to the Brussels bloc's fiscal standards.

When it gave the two countries the green light to enter the E.U., the European Commission urged them to step up efforts to fight corruption, to reduce industrial pollution and to modernize agriculture.

So, on Jan. 1, Romania is to ban cultivation of genetically altered soya, to cut out obligatory military service and to apply a new fiscal code.

And Bulgaria will on Dec. 31 close two reactors at its Kozloduy nuclear plant, a measure Brussels has demanded for security reasons.

In any case, the Jan. 1 enlargement of the E.U. looks as if it will be the last for a while.

The expansion's brakes are on, after France and the Netherlands rejected the European constitution in 2005.

Intraday Data provided by SIX Financial Information and subject to terms of use. Historical and current end-of-day data provided by SIX Financial Information. All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only. Intraday data delayed at least 15 minutes or per exchange requirements.